Product market competition and earnings management: the role of managerial ability

Abstract

Purpose This study aims to examine whether and how managerial ability is associated with the relation between product market competition and earnings management. The authors argue that high-ability managers may moderate the underlying relations in both directions, and they are likely to trade off relative costs between accrual-based earnings management (AEM) and real earnings management (REM). Design/methodology/approach This study uses ordinary least square regressions to examine the association of managerial ability on the relations between product market competition and earnings management. The paper follows prior literature to measure managerial ability, product market competition and earnings management. Findings This study shows empirical evidence that high-ability managers in high-competition industries are likely to engage in AEM but less likely to engage in REM. These findings overall indicate that high-ability managers in high-competition industries trade-off between different forms of earnings management based on their relative costliness and choose the one that is relatively less costly. Practical implications This study has important practical implications as the findings identify situations when important stakeholders, such as the board of directors and investors, may take precautions to prevent managers’ opportunistic behaviors. The findings of this study also might be helpful for firms when it comes to selecting managers. The findings may provide some input to the firms in considering the risks and benefits trade-offs of recruiting a high versus low-ability manager in a more or less competitive environment. Originality/value The findings of this study show new insight into how managerial ability moderates the relation between product market competition and different types (i.e. accrual-based and real activity-based) of earnings management.

The Tradeoff between Accruals and Real Activities Earnings Management by More Capable Managers: Evidence from Egypt

“…This result comes in line with other previous work such as Huang and Sun (2017) which concluded that managers with high abilities prefer to use accrual earnings management instead of real earnings management as they have a better understanding about the negative effect on the future performance of the firm. Similarly, Hasan et. al.…”

Managers’ perception of product market competition and earnings management: a textual analysis of firms’ 10-K reports

“…Earnings manipulation has long been at the center of discussions among standard-setters, regulators, and researchers globally (see e.g., Healy, 1985;Burgstahler and Dichev, 1997;Healy and Wahlen, 1999;Bergstresser and Philippon, 2006;Kothari et al, 2015;Luippold et al, 2015;Francis et al, 2016;Shi et al, 2018;Lemma et al, 2018;Chang et al, 2019;Fan et al, 2019;Yung and Root 2019;El Diri et al, 2020;Jiang et al, 2020;Lara et al, 2020;Bertomeu et al, 2021;Barbar and Habib, 2021;Habib et al, 2022;Hasan et al, 2022;Harris, 2018Harris, , 2023among others). This is in part due to the suggestion that the deliberate misrepresentation of reported financial performance results in earnings reflecting the desires of management as opposed to the financial performance of the firm and the danger this poses for the investing public.…”

“…We attempt to shed further light as to whether increased competition does indeed induce earnings management practices among firms. In addition, we attempt to reconcile some of the conflicting results regarding the nature of the relation between product market competition and earnings management (see, e.g., Balakrishnan and Cohen, 2013;Cheng et al, 2013;Datta et al, 2013;Laksmana and Yang, 2014;Markarian and Santalό, 2014;Lemma et al, 2018;Shi et al, 2018;Babar and Habib, 2021;Hasan et al, 2022). Despite an extensive body of empirical work covering the topic, there is little convincing evidence concerning whether increase product market competition leads to managers engaging in earnings manipulation.…”